If the US-China relationship unravels, so will the international order as we know it

Henry Paulson says relations built on the integration of goods, capital, technology and people are now threatened by the prospect of an ‘Economic Iron Curtain’ To stop disputes spinning out of control, the US must realise the futility of isolating China, while China must address criticism of its economic practices

I fear that big parts of the global economy will ultimately be closed off to the free flow of investment and trade. And that is why I now see the prospect of an “Economic Iron Curtain” – one that throws up new walls on each side and unmakes the global economy, as we have known it.

Nobody wins a trade war. And China can agree to enough of what President Donald Trump [1] seeks to enable a deal [2] that he can be proud of – if it also marks the beginning of the negotiation of a high-ambition trade or investment agreement. But I also happen to believe that the underlying tensions will persist. That is because the problems we face, and our divergence of views, even in the economic area, are much broader. Unless these broader and deeper issues are addressed, we are in for a long winter in US-China relations [3].

Trade with China has hurt some American workers [4]. And they have expressed their grievances at the ballot box. So, while many attribute this shift to the Trump administration, I do not. What we are now seeing will likely endure for some time within the American policy establishment. China is viewed – by a growing consensus – not just as a strategic challenge to the United States but as a country whose rise has come at America’s expense.

The United States played the decisive role in facilitating China’s entry into the World Trade Organisation [6]. Yet 17 years after China entered the WTO, China still has not opened its economy [7] to foreign competition in so many areas. Nearly 20 years after entering the WTO, this is simply unacceptable.

Watch: Xi Jinping pledges to open China’s markets to the world

In large part because China has been slow to open its economy since it joined the WTO, the American business community has turned from advocate to sceptic and even opponent of past US policies towards China. American business doesn’t want a tariff war but it does want a more aggressive approach from our government.

American business doesn’t want a tariff war but it does want a more aggressive approach from our government

Even though many American businesses continue to prosper in China, a growing number of firms have given up hope that the playing field will ever be level. Some have accepted the Faustian bargain of maximising today’s earnings per share while operating under restrictions that jeopardise their future competitiveness. But that doesn’t mean they’re happy about it. Nor does it mean they aren’t acutely aware of the risks – or thinking harder than ever before about how to diversify their risks away from, and beyond, China.

For 40 years, the US-China relationship has been characterised by the integration of four things – goods, capital, technology and people. And over these 40 years, economic integration between the two countries was supposed to mitigate security competition. But an intellectually honest appraisal must now admit that this hasn’t happened and that the reverse is taking place.

Security competition is bleeding extensively into economics and business. And more than that, economic tensions are reaching a breaking point. The result is that, after 40 years of integration, a surprising number of political and thought leaders on both sides advocate policies that could forcibly de-integrate the two countries across all four of these baskets. Indeed, if this trend continues, we need to consider the possibility that the integration of global innovation ecosystems will collapse as a result of mutual efforts by the United States and China to exclude one another.

Here’s the problem for those in my country who advocate a US-China “divorce”: decoupling is easier when you’re actually a couple. But the United States and China are not, in fact, a couple. There are more than two players here. And the rest of Asia, in particular, gets a vote. So the US can try to divorce China by restricting flows of goods, capital, technology and people. But what if others, especially in Asia, don’t want to follow suit? Many years of working in and around Asia have taught me this: I do not believe that any country in Asia can afford to divorce China, or even wishes to. That is a function of their geography, of economic gravity, and of the strategic reality they live with each and every day.

But let us not presume this also means that everyone, including America’s closest allies, is ready to “divorce” China, as some in Washington would now have it. On the contrary, no country, in my view, will “divorce” a major nation that remains, even amid a slowdown, among the world’s fastest-growing major economies. So, in its effort to isolate China, the US risks isolating itself.

But let us also be clear that if China wants to keep its relationship with the US from spinning out of control, it is going to have to look hard at some of its choices and policies. Above all, that means China will need to rediscover the spirit of market-driven reform and opening up, which would address long-standing criticisms while doing wonders for the Chinese economy, too.

If the US and China cannot find a way to develop a workable consensus, it will pose a systemic risk of monumental proportions – not just to the global economy, but also to international order as we know it and to world peace. Both countries need an international system that functions – because international order is one of those things that is simply too big to fail. And so the alternative is unacceptable.

A spring will come. The questions are, how long will this winter last and how much unnecessary pain will be inflicted?

Now, we are proceeding down divergent paths and we are in danger of facing a long winter before we reach what may still be a rather patchy spring. But I believe a spring will come. So the questions are, how long will this winter last, and how much unnecessary dysfunction and pain will be inflicted along the way? The answer will be determined by the capacity and willingness of leaders in Washington and Beijing to think creatively – and sometimes even disruptively.

Today’s world looks nothing like the world of the 1970s, or of the 2000s, or even of the years when my friend Wang Qishan [10] and I tackled the financial crisis. New technologies, new economic challenges, new geopolitical challenges – all of these have eroded the frameworks of the past. And so we’ve reached another of those consequential moments. And the stakes – for our economies, and for the world – are higher than ever before. We need to craft a new framework that works for today’s world, not the world of the past.

Henry M. Paulson is chairman of the Paulson Institute and a former US Treasury secretary. This article is taken from excerpts from his speech on Wednesday at the Bloomberg New Economy Forum in Singapore